Responsibilities and liabilities of the Legal Representative Foreign invested companies in China


By: Alex Wu, Donia Joevion Fuller-Barrett     On: 2016-06-01

Introduction

There are many instances, where it is evident that a foreign company has failed to grasp the true powers and liabilities of its Legal Representative. For instance, very recently the Legal Representative of a large Northern European MNC was subjected to detention for 2 days in a Chinese lock-up and was not released until a case of non-compliance was resolved. The situation out of which this unfortunate state of affairs arose is that the company added a product to their portfolio of industrial components. The addition was not a new product, but rather a larger model of what was already being produced and which was within the approved business scope. However, due to a lack of a proper compliance check system, it was not discovered that a special “production license” was needed for this particular size of the product. During an inspection of the factory the authorities became aware of the breach. Consequently, the “Legal Representative” of the company was taken into custody.

This example is not rare, thus it is important that foreign companies appreciate both the powers and liabilities which vest upon their company officials especially in cases of Joint Ventures.

The Legal Representative

What is the legal representative?

Because the Company Law of the People’s Republic of China (‘The Company Law’) whilst dictating that every limited liability company must have a legal representative, does not in fact define it, reference must be had to Article 38 of the General Principles of Civil Law of the People’s Republic of China (‘PRC’). 

The Article provides that, “In accordance with the law or the articles of association of the legal person, the responsible person who acts on behalf of the legal person in exercising its functions and powers shall be its legal representative.

Powers of the legal representative

Because the Company Law does not clearly delineate the scope of the powers of the legal representative, the individual holding that role has a very broad purview and leverage with which to act. This power includes but is not limited to the right to represent his company to outside parties in almost every aspect, which may involve binding the company to a contractual obligation. Additionally, the legal representative has the tasks of managing and organizing the company’s operations which may require him to call and preside over shareholder’s meetings, execute legal transactions, execute powers of attorney on behalf of the company to name a few. 

Moreover, as the legal representative, Article 148 of Company Law dictates he/she has fiduciary duties to the company which he/she represents, including the duties of fidelity and diligence. To that end, certain actions are clearly prohibited, such as the misappropriation of company funds, lending same without first obtaining the necessary consent and comingling company funds with those that belong to him/her. Additionally, this duty of fidelity and diligence requires that the legal representative acts in a manner that is prudent and ethical in a bid to conserve the company’s assets.

Liabilities of the Legal Representative

Actions which constitute a breach of the legal representative’s duty of fidelity and diligence are enumerated throughout Article 147 of the Company Law. These offences are all strict liability offences. This means that once the offence is committed, liability is established without a consideration of whether or not the crime was intended. To that end, even though a legal representative may not orchestrate a breach which causes losses to the company, s/he may still be found liable unless it can be shown that he was either not aware or at fault or voted against the decision.

Yet, there are other ways by virtue of which a legal representative can find him/herself personally liable. For example, recognizing the advantageous position in which a person is placed by being legal representative, the Company Law prohibits abuse of this position. Thus, a legal representative may incur personal liability if he “injure[s] the interests of the company by taking advantage of its business relationships.” In any such instance, the legal representative will have to provide compensation for the loss the company suffers.

The need for the legal representative to make compensations also arises if he takes any bribe or receives illegal gains by taking the advantage of his authority or encroaching on the properties of the company. In some instances, if he is aware of actions of others such as directors or senior officers which cause loss to the company, he may have to make compensation as this could be seen as an act of intentionally or through gross negligence, causing a loss to the company. In any such instance, he/she will be held personally liable and must make compensation for the damages that result from his actions and possibly inactions. 

Article 49 of the Civil Code also speaks to the concept of Administrative liability, which differs from civil or criminal liability. It states as follows:

“Under any of the following circumstances, if an enterprise as a legal person shall bear liability, its legal representative may additionally be given administrative sanctions and fined and, if the offence constitutes a crime, criminal responsibility shall be investigated in accordance with the law:

  1. Conducting illegal operations beyond the range approved and registered by the registration authority;
  2. Concealing facts from the registration and tax authorities and practicing fraud;
  3. Secretly withdrawing funds or hiding property to evade repayment of debts;
  4. Disposing of property without authorization after the enterprise is dissolved, disbanded or declared bankrupt;
  5. Failing to apply for registration and make a public announcement promptly when the enterprise undergoes a change or terminates, thus causing interested persons to suffer heavy losses;
  6. Engaging in other activities prohibited by law, damaging the interests of the state or the public interest.”

In each instance, the offences are considered on a strict liability basis and the legal representative is found to have joint liability with the company, and then subjected to administrative sanctions and fines. The only defense possible in such instances is for the legal representative to prove that he was either unaware of the activities or not at fault for such activities. Of importance to note as well is that the regulations on the implementation of the code allow for the detention of the legal representative for up to 15 days. Thus, it is patently clear that whilst the powers of the legal representative are great, liabilities are comparable and the role ought not to be taken lightly.

Furthermore, there are instances in which, a legal representative may be made to bear criminal liability in respect of actions of the company. As a general principle, Article 31 of the Criminal Law provides that if a "unit" (including a company) commits an offence under the Criminal Law, the unit shall be fined and its "supervisory personnel with direct responsibility" and "other person with direct responsibility" shall be punished for the same offence which, depending on the offence in question, may include a fine and imprisonment.

For instance, section 2 of the Criminal Law of the PRC creates several different smuggling offences and in each case, “with personnel directly in charge and other directly responsible personnel” may be punished in accordance with the relevant section, for the actions of the company. An example of how serious this can be is found in Article 153 which states in part, 

“Units committing offenses under the preceding paragraph shall be punished with a fine, with personnel directly in charge and other directly responsible personnel being sentenced to imprisonment or criminal detention of less than three years; and, for cases of a serious nature, to imprisonment of over three years and less than 10 years; and -- for cases of an extraordinary serious nature -- to imprisonment of over 10 years.” 

Other key offences relating to company affairs which are listed in the Criminal Law and which may result in the Legal Representative being sent to prison include:

  1. False registrations of capital (Article 158)
  2. False contributions to registered capital of a company or illegally withdrawing registered capital (Article159)
  3. Providing false financial and accounting statements (Article 161)
  4. Concealing accounting vouchers, statements and false insolvency (Article 162)
  5. Accepting kickbacks or bribery (Article 163)
  6. Obtaining any loans by fraudulent means (Article 175)
  7. Evading taxes (Article 201);
  8. Defrauding state export tax refunds (Article 204);
  9. Falsely issuing exclusive value-added tax invoices or other invoices to defraud export tax refunds or to off set taxes (Article 205)

In practice it has been observed that in order to escape liability, if the legal representative is deem to the be person in charge, he/she must submit evidence which supports his/her innocence, notwithstanding the fact that the burden of proof rests on the government. 

Other risks Associated with the Role 

Separate from the forms of liabilities aforementioned, the legal representative could also be subjected to coercive measures which can prevent him/her from leaving the country. The situations out of which thus could arise include a failure to make tax payments and where bankruptcy proceedings are commenced in respect of a company. For instance, Article 8 of the Law on the Control of the Exit and Entry of the Citizens provides that approval to exit the country is not to be provided to inter alia persons involved in an unresolved civil case. These unresolved civil cases include bankruptcy proceedings and obviously the legal representative would have a major role to play until the company is finally liquidated.

Exercise Caution in Appointing a Legal Representative

Given the immense powers of the legal representative, caution must be exercised in the matter of his/her appointment. For instance, Article 43 of the Civil Code provides that, “An enterprise as legal person shall bear civil liability for the operational activities of its legal representatives and other personnel.” Therefore, a company cannot escape liability for the actions of its legal representatives during the course of operational activities. 

Furthermore, whilst it may put a limit of the Company’s liability, if the legal representative’s actions fell outside of “operational activities” this does not generally apply to contractual dealings with third parties. Rather, Article 50 of the Contract Law of the PRC stipulates that, “Where the legal representative or the person-in-charge of a legal person or an organization of any other nature entered into a contract acting beyond his scope of authority, unless the other party knew or should have known that he was acting beyond his scope of authority, such act of representation is valid.”

Therefore, a legal representative who exceeds the scope of his authority can still bind a company to a third party and the company can only escape these obligations if the third party knew or ought to have known that the legal representative’s actions were not permissible. Even though a company’s articles of association and attendant corporate documents, must be filed with the local Administration of Industry and Commerce and can be accessed with a view to verifying the legal representatives authoritative scope, in practice counterparties usually successfully contend that they were unable to examine these documents. Evidently then, a company must be careful when appointing a legal representative, otherwise it could result in tremendous losses for the company.

With this in mind as well, it is critical that the company carefully manages its “chop” and its legal representative’s access to it. The importance of and risks attendant to the Company chop is discussed in greater detail in the fifth article in this series of five articles. At this juncture however, it is appropriate to note that in China, each company must have a chop, which must be present on a number of corporate documents as it is regarded as a signature and as such, has the power to bind the company even if it was not used by the legal representative. In view of what has been said about the legal representative’s powers to bind the company, clearly misuse of the chop is a real concern.

It is patently clear that the appointment of the legal representative is a serious matter, thus mechanisms must be put in place outside of a rigorous appointment process to limit the potential for company liability on account of the legal representative’s action. Ironically, if a company finds itself in an unfavorable position due to the actions of its legal representative, termination may be the obvious course of action, but it is not necessarily the easiest. In order for termination to be valid, the legal representative is required to sign and approve his own termination documents. It is hardly likely that in such cases a legal representative would be cordial and act in a way that facilitates his/her departure. In fact, there have been several instances where persons in this situation hold the company at ransom until an excessive termination package is offered. Thus it is recommended that as part of his/her contract when the legal representative is being appointed an undated letter of resignation and/or termination is prepared for future use if the needs unfortunately arises.

Conclusion 

Clearly, there are tremendous risks both to the company and the legal representative attendant to the role of the latter. Therefore, it is imperative that the legal representative on the one hand knows what is going on in the company – in this regard, Asia Base Law & Projects – with their Corporate Compliance Guard offers both company owners and their Legal Representatives support services in the form of establishment of a compliance system as well as audits. This way the risk of problems with liabilities arising from non-compliance with authority requirements or individual abuse of power can be reduced. On a personal level, the Legal representative may also seek to minimize the risks by entering into an indemnification agreement with the Company, purchasing liability insurance, or incorporating exemption clauses into the Company Articles of Association. On the other hand, the company must also develop and implement mechanisms which effectively curb the actions of the legal representative ensuring that the company is not bound to obligations which it cannot fulfill due to considerations of illegality or otherwise, or obligations which would not be economically prudent to have fulfilled.